Use the Force

Jon Woodhead - July 14, 2020

Use the Force

In the face of an ongoing global health pandemic, many companies are having to focus on the basics. How to achieve financial security through business continuity, resilient supply chains, new routes to market and cost cutting.  Meanwhile, another international crisis that impacts business - climate change – continues to gather pace.

The recommendations of the Task Force on Climate Related Financial Disclosures (TCFD) were first published over 3 years ago.  These focus on greater transparency surrounding how climate risk affects business success. Yet even before the Covid-19 crisis began, many companies were only paying lip service to TCFD reporting.  Now TCFD risks becoming a task with no force.  We examine the current state of play, and suggest how companies can take more meaningful steps towards TCFD reporting.

TCFD was set up with the objective to provide financial markets with more comparable and complete information about climate change related financial risks and opportunities.  TCFD structures its recommendations around four thematic areas: ‘governance’, ‘strategy’, ‘risk management’ and ‘metrics and targets’.  ‘Recommended disclosures’ are described for each of these areas and one of the key areas for disclosure is consideration of climate related scenarios, including a ‘2 degrees Celsius or lower’ scenario.  Companies are recommended to disclose how their business strategies might change to address potential implications of climate change under these scenarios. 

Aside from recommending reporting on the full scope of GHG emissions metrics, TCFD is not prescriptive in terms of indicators or methods of quantification.  What TCFD does require is a considered analysis of the implications to core business strategy of the identified climate related risks and opportunities.  It suggests four major categories of traditional financial accounting that could be affected: revenues, expenditures, assets and liabilities, capital and financing.  Example impacts across these categories are provided, and it is recognised that forecasting these impacts carries with it a number of uncertainties. 

Scenario analysis is a way of dealing with uncertainties: to enable companies to look at how various combinations of climate related risks, both transitional and physical risks, might affect business strategies and financial performance over time.  A recommended approach to scenario analysis is provided by TCFD, although it is noted that work must continue to develop: sector specific scenarios; methodologies and data sets; and industry specific guidance.

The publication of the TCFD recommendations was a major milestone – a much needed step in the right direction, with an explicit acknowledgement that continuing efforts are needed to achieve widespread adoption and improvements to the quality of climate related disclosures.

But after 3 years of developing practice, there are relatively few examples of meaningful forecasts using scenarios to describe potential impacts on core business strategies and performance.  Good examples we have seen include those from companies such as Telenor, which provide detailed estimates of future financial impacts across a wide range of potential climate related impacts on the business.  Other elements of good practice are summarised in the TCFD Good Practice Handbook, created by the Climate Disclosure Standards Board and the Sustainability Accounting Standards Board.  The examples are drawn from companies across the G20 in making the 11 TCFD recommended disclosures, although as noted by the Handbook, “we have not found any one company with full TCFD disclosures”.

The World Business Council for Sustainable Development (WBCSD) and TCFD has been working with representatives of a number of sectors to develop reporting practices.  In the construction and building materials sector, companies including ArcelorMittal, CRH, LafargeHolcim, Lendlease, Saint-Gobain and Skanska have been exploring how to complete climate risk assessment and strategic scenario building.  Progress to date is recorded in WBCSD’s latest TCFD Preparer Forum report, which observes that even for companies in the same sector: “whilst they share many climate-related risks and opportunities, impacts and responses differ depending on where a company operates within the value chain. The decisions and actions taken in one part of the value chain have knock-on effects for those operating in other areas and this can both facilitate and frustrate the transition to a low-carbon, resilient value chain”.

Similar work has been underway in the food, agriculture and forest products sector.  This sector’s recently issued report on progress, includes examples from companies including Mondi, Nestlé, Olam, Unilever, Stora Enso and Syngenta. The report details how these companies have used climate-related metrics relating to low-carbon solutions, adaptation and resilience measures, productivity and resource management.

Forum members note the need for “collaborative efforts to develop complex decision-making techniques using scenario analysis by sharing knowledge and data and building communities of practice”. They call on investors to recognize and reward positive climate action and resilience measures. Demands on policy makers include developing “clear and consistent long-term frameworks aligned with climate, agricultural, food and forestry science to create a stable and enabling operating environment”.

These Preparer Forum reports demonstrate the complexity and inter-connectedness of the issues that surround climate change.  Whilst it may be a logical ambition to boil down information into comparable metrics for easy analysis by investors, the reality is this ambition may not be achievable.  Companies do not work in isolation.  Business and climate performance is influenced by a range of factors, not least the complex and varying national regulations across which multi-national companies operate.  Action on climate change presents risk, opportunities, trade-offs, winners and losers, all of which needs to be taken into consideration when ‘accounting’ for present and future performance.

Outside of these Preparer Forums, for many companies claiming to follow TCFD, vagueness currently pervades many corporate reports on climate related risks and opportunities.  At the time of this article, the latest Status Report on TCFD (from June 2019) found that:

  • disclosure of climate-related financial information has increased since 2016, but is still insufficient for investors;
  • More clarity is needed on the potential financial impact of climate-related issues for companies;
  • Of companies using scenarios, the majority do not disclose information on the resilience of their strategies.

Many companies that reference TCFD, allude to climate change being taken account of within existing corporate risk management systems, but neglect to provide any details on how this is done, or the implications and outcomes.  What is needed now is additional pressure e.g. through legislation, or via investors, to avoid this type of “TCFD-lite” approach becoming the norm. 

Just as ESG reporting is not the same as Sustainability reporting (because ESG disclosures are designed for investors, not the full range of stakeholders), “TCFD-lite” reporting is not the same as providing a full account of a company’s approach and impacts in relation to climate change. In our view, companies starting out on the TCFD reporting journey would do well to ensure the following:

  1. Use existing risk analysis frameworks as a starting point. Some adaption of the framework may be needed to adjust thresholds of materiality, or time horizons of potential impacts;
  2. Use scenarios to calculate potential future financial impacts . Forward looking climate related financial metrics are what will make investors sit up and take notice.
  3. Set targets but only if backed by credible analysis of how to get there. ‘Net zero’ commitments may currently be ‘on-trend’, but these require fundamental changes to business models and often rely on offsetting and as-yet-unproven changes to technology and lifestyles.
  4. Take the Board on a journey. Don’t expect approval for disclosures that reveal the climate related risks and opportunities a company faces, without first establishing understanding and consensus at the highest levels.
  5. Use your scenarios as part of stress and resilience testing. Climate scenarios can be used to inform regular processes of organisational resilience testing – what if the worst happens and climate impacts are deeper and faster than the most likely scenario?

An appreciation and understanding of the context of information is everything.  In our view, a company’s actions and performance on climate change can never be boiled down to a few metrics that will be easily comparable with others.  It is imperative for the company to provide credible analysis and contextual explanation on how its actions and performance relate to business strategy and decision making.  Increased legislative and investor pressure is needed to make these reporting practices mainstream: voluntary frameworks where a ‘lite’ approach is possible, will not achieve their stated goals.

Challenge Sustainability is working with a range of clients that are reporting using the TCFD recommendations.  For more information on how we can support your company, please contact us.